Do the Shortfalls and Overhangs Derived from Money Demand in South Africa Augmented with Portfolio Balances Impact Inflation Dynamics?

Do the shortfalls and overhangs derived from money demand in South Africa augmented with portfolio balances impact inflation dynamics? The vector error correction model (VECM) results indicate that augmenting the money demand function with asset price returns leads to a lower point elasticity for GDP. The augmented money demand functions can explain developments in monetary aggregates via the substitution and international portfolio balance effects. The money demand dis-equilibria derived from the augmented money demand functions can pick up the role of asset price returns and interest rate differentials post the global financial crisis, which is absent in the conventional money demand function as it still indicates a substantial and persistent money demand shortfall. The responses of inflation relative to the 6 per cent inflation threshold to measures of the money demand dis-equilibria indicate that the asset market dis-equilibria are incompatible with long-term inflation behaviour. This means that the inclusion of international asset returns in the behaviour of the money demand explains the effects of perpetual structural changes and financial innovation. Furthermore, developments in the asset price dis-equilibria can undermine price, financial and macro-economic stability.